CME, Eurex rebuff calls to compensate members for losses

BlackRock and BNP want CCPs that recover from a default to reimburse members and clients


The chief risk officers of CME Group and Eurex Clearing have both rejected calls for clearing houses to compensate members and clients that incur extreme losses after a default.

Dmitrij Senko, CRO of Eurex Clearing, called the idea “alarming”.

Lee Betsill, CRO of CME Group, said it would “create some perverse incentives” in the event of a default. 

Senko and Betsill were speaking at a conference organised by Eurex in Frankfurt on February 27.  

If a clearing member defaults, the central counterparty (CCP) first tries to recoup losses by auctioning the defaulting member’s positions to other members. Any remaining losses are then allocated to the CCP’s own capital and to members through default fund contributions, or in more extreme circumstances, haircuts on margin posted by non-defaulting members and clients.

Speaking at the same conference, Vicky Hsu, director for counterparty risk at BlackRock, argued that end-clients of clearing members should be compensated in certain circumstances when variation margin gains haircutting (VMGH) is employed by the CCP.

“We believe clients should be compensated if any VMGH is taken, and it’s very likely that if we get to that scenario, we will be hit,” said Hsu. “BlackRock manages assets on behalf of many types of clients, including long-dated directional clients that are more liability-driven investment managers. They have derivatives positions outside of the clearing house as well, and that leads them to have very directional positions in the CCP.”

Cecile Barthelemy, global head of market infrastructure risk at BNP Paribas, made a similar point.

“If we clearing members or clients … were to suffer some losses during variation margin gains haircutting and then if the CCP comes back onto a balanced position … I think it’s fair for us to request some form of compensation, perhaps even before the CCP comes back into a profitable situation.”

The debate over compensation has taken on added significance amid ongoing discussions between the European Parliament, Council and Commission on legislation firming up CCP recovery and resolution procedures. The next round of trilogue negotiations is scheduled for March 17.

“The alarming part of it is that maybe some parts of the industry hope that the CCP can cover these losses with existing capital, future capital, future profits, different forms,” said Senko. “The good thing is that the finalisation of this regulation inspires discussion on this point.”

The EC and Council texts would give resolution authorities the power to compel clearing houses to compensate members for losses that go beyond their obligations under the CCP’s rulebook. This compensation could include “instruments of ownership, debt instruments or instruments recognising a claim on the CCP’s future profits”.

The alarming part of it is that maybe some parts of the industry hope that the CCP can cover these losses with existing capital, future capital, future profits, different forms
Dmitrij Senko, CRO of Eurex Clearing

BlackRock’s Hsu said decisions on extreme loss allocation and compensation should be taken by resolution authorities, not just the CCP in isolation.

“In a tail risk scenario, our clients’ money is subject to broad loss allocation mechanisms that are in CCP rulebooks today in the form of VMGH,” said Hsu. “We think that if we get that deep into the waterfall, it’s very important that resolution authorities … are there to manage that, so there are no spill-over losses into the broader economy, which can create more stress in an already stressed environment.”

CME Group’s Betsill retorted that CCPs already had rules that guaranteed any funds recovered from a defaulting member’s estate would be returned to affected market participants.

“Our rulebooks say every dollar we get back and we have a claim on [from] the estate of the defaulter goes back in reverse the way it was used. So if there are gains haircuts, it’s our obligation to return those funds first.”

Separately, BNP Paribas’s Barthelemy also suggested initial margin haircutting should be ruled out as a loss allocation tool.

During a meeting of the European parliament’s economic and monetary affairs committee on February 17, the committee chair Irene Tinagli indicated that this is a point of contention between those working on the CCP recovery and resolution regulation. The European Parliament supports initial margin haircutting, but the Council is more cautious.

“Parliament expressed strong concerns over the council’s position, which could undermine the protection of taxpayer funds and the incentives for clearing members and CCPs to manage ex-ante the risks and participate in the recovery and resolution process,” Tinagli said.

Additional reporting by Samuel Wilkes

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